The use of eminent domain by some local governments to force underwater mortgages from private-label mortgage backed securities to be restructured at a discount could harm mortgage markets, impose losses upon MBS investors and may not be legal, according to a letter from several mortgage associations.

NAFCU also submitted a separate letter on the topic. The Federal Housing Finance Agency, which runs Fannie Mae and Freddie Mac, issued a request for comment Aug. 9 in which it expressed “significant concerns” about the practice.

San Bernardino County and the cities of Fontana and Ontario, all located in Southern California, proposed such action and have already formed a Joint Powers Agency that is empowered to seize residential mortgages held in private securitizations, and transfer them to other lenders who would refinance them at a significant discount, according to a memorandum submitted with the letter submitted by the Mortgage Bankers Association, American Bankers Association and 24 others.

“The use of eminent domain in this manner will confront lenders and investors with an unquantifiable new risk,” the letter said. That risk would cause loan originators to “underwrite in a defensive manner, therefore reducing credit availability,” the associations continued.

The letter also included a table that illustrated how the practice would result in a nearly 47% loss for MBS investors, which include individuals building retirement savings.

NAFCU President/CEO Fred Becker said the actions in SoCal have been duplicated or attempted in other states.

Carrie Hunt, general counsel and vice president of regulatory affairs, penned NAFCU’s letter and said the group would strongly support appropriate action by the FHFA to halt the impact of eminent domain programs on mortgage lending.

“We’ve been concerned about the impact of forced modification of mortgages,” Becker said. “Unlike a bank, where the loss goes to the stockholders, credit unions losses go to members, and we feel credit unions are already good about working with members when they can.”

Hunt agreed with the mortgage and banking associations, which told the FHFA the programs would negatively impact credit availability.

“ Fundamentally, the use of the vast governmental power of eminent domain to restructure mortgage loans is dangerous and could, especially if the use of such power for this specific purpose spreads, impede the recovery of the housing market,” she wrote. Becker said it’s his understanding the use of eminent domain in such cases “have some constitutional issues”, an opinion shared by the bankers.

“The U.S. Constitution permits government seizure of private property only if such takings are made for a public purpose in exchange for just compensation,” the associations wrote in their letter. “The likelihood of any material public benefit arising from these proposals is very low, and the fact that the proposals would transfer profits from one private party to another renders the exercise of eminent domain here constitutionally defective.”

Furthermore, the losses that would be suffered by existing investors would not satisfy the “just compensation” requirement, the groups said.